Trade Liberalization Impact on the Indonesian Palm Oil Industry

Citation

Abstract / Synopsis

The palm oil industry has been an important sector in the Indonesian economy for
the past three decades. The important role of this industry to the Indonesian
economy is not only due to the fact that Indonesia today depends substantially on
oil palm for its foreign exchange earnings, but also because Indonesia is the largest
consumer of palm oil among developing countries. This study was conducted to
analyze the implications of various trade liberalization policies (reduction of export
duty and import tariff) on the Indonesian palm oil industry.
An econometric approach, mainly the error correction model on a simultaneous
equation model, was employed. The model incorporated specific equations for
acreage, harvested area, yield, domestic demand, rest of the world excess supply,
Indonesian excess demand to India, China, Europe, and rest of the world, rest of the
world excess demand and export price. The model was estimated using error
correction and simultaneous model technique. Then the model was estimated by
the two stage least squared (2SLS) method. The structural equations were assessed
based on the economic and statistical criteria. The economic criteria were evaluated
based on the signs and magnitude of the hypotheses, while the statistical criteria
used the coefficient of multiple determination (R~)t,h e F statistic, auto correlation (h
statistic), and t ratios to assess the model. Validation of the model was undertaken
using Theil's inequality coefficient and root mean percentage square error.
The results show that the net social welfare effects of export duty reduction at 10%
showed a net gain for $ 857.56 thousand, which can be explained by gains in
Indonesian producer surplus as a result of higher prices and by transfemng the
production resources from palm oil production to more efficient sectors. Indonesian
consumers' surplus decreased by $12.89 million, while Indonesian producers'
surplus gained $17.38 million. On the other hand, when import tariff was reduced
by lo%, the estimation yielded a gain in Indonesian producers7 surplus of $ 5.42
million, a gain of $ 1.38 million in efficiency attributable to the transfers of
production resources to more efficient sectors and a loss in consumer surplus of
$4.04 million due to increased production at higher prices. These numbers
increased along with the increase in the percentage reduction of export duty.
Reduction in both export duty and import tariff has the same implication as
individually reducing export duty and import duty. Producer surplus increased by $
22.83 million and efficiency gain rose by $ 1.51 million, meanwhile the loss in
consumer surplus was $16.54 million. Then, the calculations of the welfare effects
showed that the Indonesian palm oil industry will be better off without any
intervention.